Does gambler’s ruin apply to the stock market?

A question from Yahoo! Answers:

Does gambler’s ruin apply to stock markets?

There are at least two issues to consider here, (1) game theory and (2) market structure. Let’s take game theory first.

Gambling is a negative-sum game (for every dollar someone loses, there is less then one dollar someone else wins, because of the “house take”, or casino fees). The average gamble, therefore, is a small loss by the gambler to the house.

The stock market, in contrast, is a positive-sum game (over the long periods of time, stocks go up, because they represent ownership of actual companies, the majority of which are value-adding concerns). So the average stock investor wins about 12% per annum in the long haul.

And now for something completely different (market structure, that is)…

There a phenomenon called “market impact”; large trades cause the market to move against the trader, so large purchases are slightly (and sometimes substantially) more expensive, while large sales are slightly (and sometimes substantially) cheaper.

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